Hang Loose

By

William Pesek Jr.

Updated Oct. 2, 2000 12:01 a.m. ET

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S teps away from Prague's picturesque Old Town Square, several hundred black-clad pro testers are staging what organizers call a "death march." The procession, led by a 12-piece funeral band and sign-waving activists, features banners bemoaning the "lives lost to capitalism" and the countries "ruined by globalization." The targets of their hysteria are the swarms of economic policy-makers and bankers in town for the annual meetings of the International Monetary Fund and the World Bank.

One of the more animated demonstrators wears a T-shirt featuring the face of Alan Greenspan, the chairman of the U.S. Federal Reserve. "He's kind of the face of capitalism and basically everyone has heard of him," fumes Melina Koll, a slight-framed, 22-year-old Czech student. "If we can get Greenspan's attention, then we are achieving something."

While the protesters decry the workings of the free market, officials and financiers here -- the 74-year-old Fed chief included -- marvel at the U.S. economy's ability to grow strongly without generating inflation despite the tightest labor markets in a generation. And some wonder why the Greenspan Fed isn't hiking rates further in the face of above-trend growth. The reason for his tolerance, of course, is America's ongoing productivity shock -- emphasis on "ongoing." Indeed, unlike the kids in the street and the old codgers in the conferences, Fed insiders tell Barron's that Greenspan and many of his colleagues think the U.S. economy's best days may be yet to come.

As a long-time central banker, and a Wall Street economist before that, Greenspan isn't naive about the upside risks in the economy. Clearly, surging oil prices are the last thing he wants to see. And recent signs of declining corporate profits are equally disturbing; the trend could remove a cushion that has enabled many companies to avoid raising prices. But when he pores over data and anecdotal reports, Greenspan detects little to suggest that the glow of the New Economy is dimming. In fact, it may get brighter still.

"One thing you see from the economic figures and the stories you hear around the nation is that productivity isn't slowing," says one senior Fed official. "In fact, it's more likely that it's accelerating, and that hasn't eluded the chairman."

It's a dynamic the central bank will examine this week as the Federal Open Market Committee gathers in Washington to discuss interest-rate policy. The vast majority of observers think the FOMC will leave rates alone and may continue to do so through the balance of the year. That Fed officials -- including Greenspan -- are doing nothing to dispel that notion should be kept in mind when pondering the outlook for U.S. monetary policy.

Fed officials increasingly are returning to the drawing boards they erected in 1996 when the economy's unique mix of strong growth, low unemployment and tame inflation first began confounding policy-makers. Four years later, few at the central bank doubt that the economy's speed limit has risen markedly since the mid-'Nineties. But a key question for the Fed now is whether productivity gains are picking up steam even today. The query is far from academic, as the answer will have a direct bearing on whether or not the FOMC needs to raise rates in the year ahead.

Greenspan thinks we've yet to feel the full benefits of the telecommunications and computer revolution that's swept the economy. And what the Fed is hearing these days -- particularly from district Fed banks scattered around the nation -- is that the downshift in growth may actually spur a new wave of productivity-enhancing, high-tech spending.

That runs counter to the conventional wisdom that a slowdown would end the productivity revolution. But faced with intense global competition, which limits pricing power, and the constraint of a dwindling pool of labor, Corporate America has to boost productivity or see profits suffer. While this keeps the pressure on managements -- and their companies' stock prices -- it gives comfort to Fed officials these days, notwithstanding rising oil prices. That's partly because it takes half as much oil to generate $1 of economic output as it did in the 'Seventies, Fed staffers note. Also, the current energy shock comes amid low inflation and a strong dollar. "Oil is certainly an upside risk, but not in the way it was in the past," explains one senior Fed staffer. "And if you look at core inflation [which excludes volatile energy and food prices], the spillover effects have been less severe."

The energy market's positive reaction to the Clinton Administration's release of 30 million barrels from the nation's oil stash may soothe some nerves at the central bank. While the intervention wasn't large enough to have a lasting effect, it caught the attention of oil-producing nations and companies. U.S. Treasury officials think the "announcement effect" of the move is calming the energy markets.

Yet Fed officials are loath to let down their guard against inflation. In large part, that's why the central bank has maintained an inter-meeting bias toward tightening. Even Treasury Secretary Lawrence Summers harbors concerns about the economy. In Prague, Summers told a group of reporters: "The fundamentals of the economy are sound." But he added that "it will be important to avoid any possible bottlenecks in the economy, particularly in the labor market, by helping everyone move into work."

Another risk Summers is eyeing is the dollar's value. In the wake of the U.S. participation in intervention with other Group of Seven members, he's deftly handled the prickly issue of helping to support the euro, while maintaining the Administration's strong-dollar policy. As Summers well knows, the U.S. has much to lose from a plunge in the dollar, which would boost inflation and interest rates, and in turn batter the stock market. Neither, however, has the euro's slide been in America's best interest. Not only does it destabilize global markets, but it also threatens the profitability of U.S. companies operating in Europe, a fact much on the equity market's mind of late. The euro stabilized above 88 U.S. cents, compared with the 85-cent range before the G7 intervention.

From the Fed's perspective, a strong dollar is still desirable. In recent years, the firm greenback has shielded America from import inflation, while helping to attract foreign capital needed to fund the gaping current-account deficit. That's why Greenspan & Co. may have even less interest in a softer dollar than Treasury officials do. And if the dollar begins to trend lower, the Fed's inflation concerns could intensify.

But for the time being, Greenspan seems happy with the course he's set for the economy. It doesn't mean another tightening can be ruled out, especially if inflation suddenly reappears. These may be challenging times to be at the U.S. central bank, but they're the kinds of tests that most central bankers would gladly trade for their own.

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